Coronavirus ringing alarm bells for LatAm SMEs

The sharp and persistent depreciation of Latin American currencies is ringing alarm bells among governments and small and medium-sized companies (SMEs) across the region.

One of the main fears of authorities and small companies is production shortages that could lead to liquidity problems. 

Most economists are calling for central banks to make cuts in basic interest rates and banking authorities are weighing up whether to make any reductions, "but, in my view, that won't solve a problem that we're rapidly seeing; the lack of liquidity for small and medium-sized companies,” Luis Octavio de Souza Leal, chief economist at Banco ABC Brasil, told BNamericas. 

“Here in Brazil LG halted its production due to problems with supplies from China, but LG is a major company so they won't have any major problems in the longer term. However, for small companies, stopping their activities for weeks can result in a wave of bankruptcies, so monetary authorities and development banks must to be ready to provide short-term loans, cash flow for those firms,” added Leal. 

Since the appearance of the first cases of coronavirus in China, assets in the region – including currencies, stocks and bonds – have weakened and the scenario has continued apace recently as the virus has spread across the globe. 

With the expected economic impacts, most economists began predicting a new monetary easing cycle across Latin America in order to mitigate any effects on economic activity. These forecasts, which have already been priced in by many investors in the region, led to a major side-effect, the acceleration of the depreciation of local currencies, as many opted to park their money in bonds of developed nations, since emerging markets are no longer offering attractive yields.

This week, followed the US Federal Reserve's decision to cut the benchmark interest rate, Brazil’s central bank published an statement highlighting that it will also consider monetary easing due to the situation in the capital markets. 

After the bank made that comment, the real suffered an even more rapid depreciation against the US dollar, and now, the monetary authority is no longer entirely convinced that additional monetary easing will be a positive contribution, as the Selic base rate is already at its lowest level ever (4.25%), according to a high-ranking government official consulted by BNamericas. 

In addition, the depreciation of local currencies and company share prices is also a major concern due to the dollar-denominated debts of certain firms and also because of the vulnerability of those companies, particularly those that are publicly listed, to hostile takeover bids from international corporations that have more financial firepower. 

LATAM SCENARIO

The depreciation of Latin American currencies is affecting all of the countries in the region, although some are more exposed than others.

The Brazilian real, Chilean peso, Colombian peso, Peruvian sol, Argentine peso and Mexican peso have all depreciated significantly against the US dollar this year, hitting record lows. 

“The declines for Brazil and Chile are the most pronounced, falling 12% and 9%, respectively. The depreciation reflects a number of factors including commodity declines, downside risk for economic growth, and heightened political and investor uncertainty,” said Fitch Ratings. 

The ratings agency underscored the potential effects on companies in the region. 

“Most of Fitch’s rated-portfolio for regional exporters and issuers with operations abroad exhibit a natural hedge for FX risk, given US dollar-denominated debt is matched by US dollar-denominated cash flows generated abroad. Additionally, many non-exporters with US dollar-denominated debt financially hedge exposed FX positions. However, depending on the extent of depreciation and coronavirus’ impact on the global economy, all issuers would likely be affected by slower economic growth and reduced consumer purchasing power, absent policy response,” it said. 

According to Leal at ABC Brasil, even the countries in the region that are least exposed to China, such as Mexico, can see the scenario deteriorating further. 

“There are already signs of major spread of coronavirus into Europe and the US and if a similar decision is made in those countries to halt industries, as happened in China, it will cause problems in the global supply chain,” said the economist, who highlighted that after coronavirus peaks, an inflationary effect will likely occur in various regions, due to the resumption of economic activity in various segments at the same time.